Bond king Bill Gross could be stocks’ best buddy

Commentary: Report of the death of the equity cult is premature

SAN FRANCISCO (MarketWatch) — Could Bill Gross be a closet stock bull? That’s one way to view the proclamation from Pimco’s co-founder and co-chief investment officer that stocks are no longer an asset to have and to hold.

“The cult of equity is dying,” Gross wrote in his August “Investment Outlook” newsletter, published Tuesday. “An investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously ‘safer’ investment than a diversified portfolio of equities.”

Pimco

Pimco’s Bill Gross.

Historically, investors have enjoyed a 6.6% return from stocks, after inflation. Gross said he doesn’t believe the long-run record can repeat.

“The legitimate question that market analysts, government forecasters and pension consultants should answer,” Gross wrote, “is how that 6.6% real return can possibly be duplicated in the future given today’s initial conditions which historically have never been more favorable for corporate profits.”

It can’t, he concludes. But the bond king isn’t loyal to his own subjects, either. Said Gross: “With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds — and the bond market — will replicate the performance of decades past.” Read more: Why stocks could beat bonds over the next 20 years.

Inflation dead ahead

What Gross does expect is inflation — lots of it. “The cult of equity may be dying, but the cult of inflation may only have just begun,” he said. Inflation is the “magic potion” that policymakers use to worm out of fiscal holes, Gross said. Inflation kills long-term bonds and stocks also fare poorly, he noted.

“If profits can be reflated to 5–10% annual growth rates, if the U.S. economy can grow nominally at 6–7% as it did in the 70s and 80s, then America’s and indeed the global economy’s liabilities can be ‘reflated’ away,” Gross wrote.

” The problem with all of that of course is that inflation doesn’t create real wealth and it doesn’t fairly distribute its pain and benefits to labor/government/or corporate interests,” Gross added. “Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.”

Stock investors should be pinching themselves. This is the same Bill Gross who on more than one occasion over the past decade has said that he wouldn’t be surprised if the Dow Jones Industrial Average
DJIA, -0.32%
sank to 5,000.

Gross last floated this balloon in December 2008, three months before the market bottomed.

“Dow 5,000?” Gross wrote at the time. “We don’t have to go there if current domestic and global policies are focused on asset price support and eventual recapitalization of lending institutions. But 14,000 is a stretch as well.”

At last check, the Dow had stretched pretty close to 14,000. It closed just over 13,000 on Tuesday.

Gross also shorted Treasurys in 2011, a decision he quickly reversed. The average long-term U.S. government bond fund is up 34% in the past 12 months.

And if Gross is right about inflation? Bondholders get thumped, true, but the picture for stockholders depends on the rate of inflation. High-inflation environments favor commodities and real assets, including real estate. Moderate inflation, meanwhile, tends also to benefit stocks — especially shares of companies with purchasing power and which can pass along price hikes to customers. And though Gross didn’t mention them by name, inflation-protected Treasury securities, or TIPS, are bonds geared to protect investors from rising prices.

So why is Gross’s eulogy for America’s equity culture potentially bullish for U.S. stocks? One reason is that at Pimco’s most recent Secular Forum, a big-think event held every spring, the moderate inflation scenario was deemed the most likely outcome.

To paraphrase Mark Twain, reports of the death of equities have been premature and, for contrarian investors able to brave the pessimism, a buying opportunity.

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